What is third-degree price discrimination?

Third-degree price discrimination, also written 3rd degree price discrimination, splits buyers into groups the seller can identify, such as students, seniors, residents of a country, or people buying at off-peak times, and charges each group its own price for the same product. The price gap does not come from a difference in the cost of serving each group. Common examples are student and senior discounts at cinemas and museums, cheaper matinee tickets, and the same subscription priced differently across countries. It differs from first degree, where each buyer pays their own maximum willingness to pay, and from second degree, where buyers sort themselves by choosing a quantity or version from a menu everyone sees.

Three conditions must hold. The firm needs market power, since a price taker in perfect competition has no price to vary. It must be able to identify the groups with a signal it can check, such as a student ID, a date of birth, or a billing address. And it must prevent resale, because if students could resell cheap tickets to adults, the two prices would collapse into one. That last condition is why the practice is so common for services such as tickets, travel, and software licenses, which are hard to pass on to someone else.

The profit rule is to set marginal revenue equal to marginal cost separately in each group. Because the groups have different demand curves, they have different marginal revenue curves, so the same marginal cost leads to a different price in each. The group with less elastic demand, whose quantity responds little to price, pays the higher price, and the group with more elastic demand pays the lower one. Students and seniors often have tighter budgets or more flexible time, which makes their demand more elastic, and that is why they tend to get the discount.

Here is an illustration with made-up numbers. A cinema faces adult demand of P = 16 - 0.1Q and student demand of P = 10 - 0.1Q, where Q is tickets per night, and each extra ticket costs $4 to serve. Marginal revenue has the same intercept as demand and twice the slope, so adult MR = 16 - 0.2Q. Setting 16 - 0.2Q = 4 gives Q = 60 and a price of 16 - 6 = $10. Student MR = 10 - 0.2Q. Setting 10 - 0.2Q = 4 gives Q = 30 and a price of 10 - 3 = $7. Profit is (10 - 4) x 60 = $360 from adults plus (7 - 4) x 30 = $90 from students, or $450. With one price for everyone, the best the cinema can do is $8.50, selling 75 adult and 15 student tickets for a profit of (8.50 - 4) x 90 = $405, so separating the groups earns $45 more.

Compared with the single price, adults now pay $10 instead of $8.50 and students pay $7 instead of $8.50, so adults lose consumer surplus and students gain some. In this example total tickets stay at 90 either way, consumers as a whole lose $67.50 of surplus, and the cinema gains $45, so total surplus falls by $22.50. Third-degree price discrimination can raise total output and total surplus, mainly when it lets the firm serve a group that a single price would have priced out entirely; when every group is already served, as here, output need not rise and total surplus can fall. The other two degrees, the welfare comparison, and an airline version of the calculation are in price discrimination explained, and the single-price starting point is the monopoly graph.